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Mergers & Acquisitions, Webinars

Buy-Side Essentials for M&A Transactions | Webinar Recording


This webinar discusses the current mergers and acquisitions marketplace, where buyers are finding themselves up against greater competition. This landscape creates more vulnerability for paying above fair market price and missing red flags that may create greater costs post-acquisition. This webinar covers important details that buyers should know as they begin their acquisition process.

Key topics include understanding the seller, market risks and challenges, asset sale vs. stock sale, key financial and tax due diligence considerations, pre-transaction structure planning, and more.

The webinar was presented on February 10, 2021.

Click HERE to view the presentation slides.


James A. Cordova, CPA, MST  is the firm’s managing partner and serves on the Windes Board of Directors. He joined the firm in 1991 and has 30 years of experience in public accounting. Jim specializes in analysis and selection of business entities, tax factors and implications related to business dissolutions, mergers and acquisitions consulting, and tax strategies involving real property transactions.

Christy E. Woods, CPA, MST is a Partner in the firm’s Tax department and is also the Partner-in-Charge of the firm’s Long Beach office. Christy serves a wide variety of clients in real estate, construction, professional services, and high-net-worth individuals, focusing on tax planning and consulting for businesses of all sizes, as well as mergers and acquisitions and tax compliance for corporations, partnerships and LLCs.

Jeffrey H. Parsell, CPA joined Windes in 2007 and is a Partner in the firm’s Audit & Assurance Services department. His primary focus is on middle-market domestic and multi-national companies, as well as small to large closely-held businesses. Jeff possesses technical expertise and knowledge in mergers and acquisitions, audit and assurance, and regulatory compliance and enjoys working with clients to help them achieve their goals.

Trent Bryson, CEO of Bryson, has established success as the head of one of Southern California’s leading insurance brokerage and corporate retirement firms.

Brett Hlista, Bryson Vice President of Property & Casualty has 20 years of experience as a commercial insurance, property & casualty broker with a background in life & disability insurance.

The right mergers and acquisitions strategy presents a great opportunity for parties to achieve their goals on both sides of a buy/sell-side transaction. For questions or more information regarding M&A strategy please contact Jim Cordova, at or 844.4WINDES (844.494.6337).

Jason Feifer:

In the current mergers and acquisitions marketplace, buyers are finding themselves up against greater competition. This landscape creates more vulnerability for paying above fair market price and missing red flags that may create greater costs post-acquisition. So what are you to do?

Well, my name is Jason Feifer, I’m the Editor in Chief of Entrepreneur magazine. I am so glad to bring together experts who can answer just this. They are going to have an insightful discussion about the important details that buyers should know as they begin their acquisition process. We are going to be talking about understanding the seller, market risks and challenges, asset sale versus stock sale, key financial and tax due diligence considerations and more.

There are a lot of people who are going to be presenting this to you, a absolute powerhouse. I’m just going to introduce one of them and then I’m going to turn into over to him and he can introduce everybody else, he is Trent Bryson CEO of Bryson one of Southern California’s leading insurance brokerage incorporate retirement firms. He has brought together some of his team as well as the team from Windes. Windes a top 100 accounting firm focusing on middle market companies.

This is going to be a really fascinating conversation, we have so much knowledge here in this webinar right now. Trent, I’m handing it over to you, take it away.

Trent Bryson:

Awesome, thanks Jason. We’re really excited to have the team from Windes and the team from the Bryson on there. Entrepreneur, thanks for having us aboard. We’ve seen just a huge increase in the amount of firms that are looking to buy other companies and a lot of that increase comes with a lot of questions.

So, you have myself the CEO of Bryson, as Jason mentioned we are an insurance brokerage firm based out in Southern California and my partner Brett Hlista who runs our property and casualty division, Jim Cordova the Managing partner at Windes, we’ve had a long relationship with Windes and find them to be highly competent and one of the best firms in Southern California that we’ve ever dealt with, Jeff Parsell another partner along with Christy Woods. So, a lot of people coming at you with a lot of information.

We’re going to try to keep this quick and exciting as far as mergers and acquisitions can go for quick and exciting and bring you a lot of information at the end or during. Don’t hesitate to reach out with questions. You’ll also see a similar slide at the end that gets all of the email addresses so if you have any individual questions for anybody on here, don’t hesitate to reach out and we want this to be very interactive.

As we get into the presentations, you’re going to see several slides that walk you through kind of what we’re doing. Some of the first things that we see is understanding who the seller is. All too often we get this deal hunger of, “Hey, I want to go buy either a first firm or your second or third,” and so what it really becomes important is some of the questions we see is the last thing you want to do is take what you’re doing away from your daily operations of operating and selling and producing those orders and filling those orders and all of sudden go and spend a whole lot of time on a merger and acquisition that fails.

And so we want to set you up for as much success as possible. So, I think the first thing that I’m really shocked that nobody asked enough is, “Has the owner been through this previously?” We all like to be courted in life and often times there are those that love to be courted more than others. And so, what you really want to understand is, is this somebody that just likes every few years to be courted and asked about some of their business and likes to have an idea of what that process looks like and what the value is for their own ego? Are they generally interested in selling their business? Are they generally interested in the synergies that are provided in growing and merging into something greater? And I think that that’s a pretty good conversation to have and it’s a very easy conversation but you got to dig deep.

One thing that also comes up is, “Yeah I did go through this.” It does not mean that they’re not relevant or you should walk away from the table right away. It’s, if it did not work, why not? What were some of the deal points? What were the things that you liked about the last deal? What were some of the things that you didn’t like about the deal and why didn’t you ultimately come together with a sale if that was something you really wanted? As we get into the emotions, I think that that’s something that we don’t look at as often. And when I say the emotions, if you think about who you’re buying, you’re generally buying somebody that has poured their heart and their sweat, years of work into this business and so for you to neglect the emotional part of the sale I think can be a really big mistake.

As people get through with their own negotiations they’re so used to dealing with what they normally do, which is love their dollars and cents, that they forget that there’s just such a heavy emotion to this and a lot of times somebody is going to sell something that they’ve literally built their whole life. So it becomes really important to do that. And then as you really look at the emotions of the sale, do they want to go to a strategic or do they want to go to a private equity type firm?

Sometimes a strategic works really well because it’s easy, they understand the business and it’s something that’s easier to go into. There are times where I hear a business owner that says, “I am not signing my business to my competitor that I’ve had for 30 years and hated or gone head-to-head or have these different issues with them.” In that case a lot of times a private equity firm works better and a lot of times in that private equity firm, if they’re buying you they’re looking at things or as they’re going to buy firms, you’re getting just some different ways of looking at things. So, a lot of times as a buyer of a business, companies are going out reaching out to private equity firms and say, “Hey, will you help me go buy these several businesses? I need your expertise on these mergers and acquisitions.” So it works well with both. As we go on to the next slide-

Jim Cordova:

If I can just add, one thing I always suggest is to make a list of deal breakers and make it upfront. This really helps avoid making emotional decisions later, I also suggest making a list of negotiable factors and write down how much you’re willing to give on each of those issues. And I’d say lastly, keep your eye on the big picture, time and time again you’ll most likely have to have a relationship post-close with the seller. So, this could be in or out, equity carry an employment agreement.

Trent Bryson:

Yeah, the last thing you want is go through a contentious buy process and that owner isn’t wishing you goodwill. You want them to be your biggest fan, you want them to be supporting you and supporting the transition. So, thanks for bringing it up, Jim.

The second part of it is finding good M&A representation. I talked a little bit about possibly using a private equity partner but a lot of times when you’re buying you may not want to do that, you may want to do the deal yourself. So first thing to do is to talk to your bank, talk to your equity partners and say, “How are you going to finance that? Where’s this money going to come from?” You don’t want to get all the way through a process and not be able to come up with the money because times have changed or all of a sudden there’s a longer period to get financing than you originally imagined. I would say work that out upfront because there are certainly deals that have died because they got to the financing portion and there just wasn’t enough money to be there.

Then the second part is, who’s going to handle the legal and accounting? All too often we tend to go to the person we trust the most. The person we trust the most may be our brother in-law or our golf partner or tennis partner but they’re not necessarily the most versed at mergers and acquisitions. There’s different language, there’s different uniqueness to buying a company that makes it really important. So the person that’s done your taxes for the last 30 years may not be the right person.

That’s a hard thing to do but I would say that make sure you’re asking that question to your team of advisors. Which is, “How many of these mergers and acquisitions have you helped client’s go through?” Even if it’s your same partners or your new partners, you want to interview them and make sure that they’re the right partners going forward. And Jim, I think you can probably elaborate on that for me?

Jim Cordova:

Actually, stepping back, if you’re going to finance, your point Trent, find out if your credit facility is going to require a special purpose entity to acquire the target. Knowing that upfront is really important. You also want to be aware of debt covenants, time and time again we’ll see deals… And I would suggest modeling post-close cash flow to see the impact of leverage especially on high interest debt. And I would say again, I can’t stress the importance of a collaborative team, you also want find out if your legal team has tax teams or just transactional team because that will definitely change the landscape.

Trent Bryson:

Yeah, as we go into the next slide, you’ll also see what I’d say is, you expect to build out your checklist so what’s going to happen? How are you going to do a buy/sell agreement? Again, the more of this you start to put a lot of thought into the earlier on the better. So for us looking at the operating agreement and understanding they buy/sell what happens if the seller or the buyer unexpectedly gets hit by a truck, an untimely death? How are you going to terminate the agreement, the partnership? How are you going to be able to walk away, as Jim talked about earlier?

It’s important to have that outlined up front so that you don’t get into a situation where that seller is going to you or going to your client’s three years from now saying, “Oh, I got screwed!” Or, “This happened to me.” And then all of a sudden that relationship they’d built with a long time is hurting the new relationship.

Understand what the terms of that agreement and what the termination is going to look like. What happens if somebody gets disabled, death, right of refusal and then also the tax implications. And with that I’ll kind of turn it over to Jim on the tax implications and setting it up properly.

Jim Cordova:

Yeah. To that point I try to mention how important it is upfront to get the target’s organizational chart and the ownership of the target. I can’t tell you how many times we find other entities in the middle of a deal that we didn’t know about and that just certainly causes problems.

And as far as your diligence checklist it really should include all things legal, financial and tax components.

Trent Bryson:

Yeah, if you’re a coach of a football team, you want to set the game plan out in advance. And the same thing with buying a company is you want to get all of these worked out in advance, which can be sometimes frustrating because you’re thinking, “What if the deal doesn’t happen?” But it’s generally a commitment that you are going to go out and buy companies similar to yourself or companies that can complement what you’re doing. And so build that game plan out, build out your checklist, get your team of advisors in advance so that when you walk into a situation you’re confident and you know.

We see it where all of a sudden somebody comes in ill-equipped, they don’t have the right team of advisors, the other team actually does the right team of advisors and then all of a sudden they start to lose some of the early battles. So, it becomes important to have that team set up front.

As we go on to the next slide here, you’re going to see, kind of, some of the buy-side due diligence that the team from Windes is going to walk you through.

Jeff Parsell:

Thank you, Trent. Yeah as Jim and Trent talked about, ideally the seller already has its advisement team together, which helps the seller get organized before or during the planning of the sale and identifying a buyer. So, we’ve seen situations where the corporate legal entity and entity structure documents are not in place, as Jim mentioned, cap table etc., were not up to date.

We’ve also seen things like compensation plans and third-party contracts that weren’t initially disclosed, which you want to know upfront before you get further down the line in negotiation. Also, as part of the seller’s initial process is they obtain an initial value of the company which through due diligence you will validate. So after a sufficient amount of due diligence then the parties agree on a revised value. So as a buyer it’s good to know up front, again, the potential gaps in value and what the seller thinks it’s worth versus you as a buyer thinks it’s worth.

The seller may have a target amount in mind to support a new venture or retirement lifestyle. So buy-side financial due diligence is really critical, usually entails a quality of earnings for a few of the engagements which is really a critical element for negotiation since typically reveals many things that you wouldn’t otherwise discover. So the ultimate goal here is to understand exactly what you’re buying and how it integrates for future growth and profitability so you don’t overpay for the target.

Finally, in the deal structure buyers and sellers have different desires, sometimes opposing desires for their own benefit, so that’s one of the reasons that tax due diligence is so important. Jim and Christy will cover that from the buyer’s perspective shortly. So as we move over to the next slide just a few notes on preliminary deal terms, once you’re going to sign the NDA you start some basic due diligence to see if you’re comfortable to move forward as a buyer toward an LOI or return sheet. That will generally describe the terms of the deal but it’s generally understood to be non-binding. So this is really a starting point to begin the negotiation process and due diligence.

However, they otherwise can contain some certain enforceable binding provisions such as confidentiality, exclusivity. Exclusivity or no-shop says, the seller during this time of due diligence, whether it be 60, 90 days whatever that is, agrees not to market the business or have discussions about selling the business with anyone else. So it gives you as the buyer plenty of time to complete buy-side due diligence, ideally things move along as planned, and negotiate without interruption or fear of a competition.

So, ideally you could get the seller to include exclusivity especially if you not interested in getting into a bidding war. Couple of notes on break-up fees. If there’s a breakup fee to the seller in the event that the buyer backs out, you want to limit that amount, you want to be sure what constitutes the breakup fee is clearly defined. So for example if you have fraud, anti-trust, that the seller backs out, the agreement should specify those items that are outside of your control as a buyer so it wouldn’t trigger a breakup fee. And then another point there is you may be able to include a mutual provision where there’s a breakup fee to the seller that the seller will need to pay if the seller backs out.

Finally, one more note here in initial phases is non-solicitation that the seller requires non-solicitation provisions for employees, customers, suppliers in case the deal doesn’t close. You want to make sure those provisions are mutual, you may want to… It’s important to you if you have concern to restrict the seller to protect your business in the event the deal doesn’t close.

Jim Cordova:

You talked about the LOI, just want to mention broad versus specific term differences in the LOI. The more that is contained in the LOI the less there is to negotiate over in the purchase agreement. And back to your comment on the exclusivity comment 60, 90 days I just want to mention, you need to be ready to get your team ready to go once the LOI is signed because the clock starts ticking.

Jeff Parsell:

Great point, thank you Jim. Yeah you really need to be ready to go and have your team in place. Appreciate that.

So, let’s move on to the next slide here. As I mentioned buy-side due diligence usually includes obtaining a QV study where those findings are presented in a QV report. So this typically, like I said, it encompass many things that you wouldn’t otherwise have access to and it gives it a more current and future understanding of the value of the business. You wouldn’t necessarily get that from historical financials even if they’re audited, so it’s really important. Also it serves as an aid to management when it’s time to combine the business and start integrating the operations.

So, at that point you already have all the information and knowledge you obtained through the QV process so you’d be more prepared and then the integration and transition steps to be perform more smoothly at that point. And then although a QV’s heavily focused on financials, with a really specific focus on sales and sustainability of earnings, we also look at other areas in the business and provide qualitative information about the target and report, which I’ll touch on in the next slides.

So, there are as I mentioned non-financial statement items that we look at in the QV. Those can include the owner’s involvement in the business that’s closely held, customer information, industry information, company’s culture landscape. For example, if it’s a small business and the owner has to drive the business day-to-day and that owner’s exiting, has the seller already started putting those systems in place to decentralize those processes? Also, you want to know what the impact of that is. If the owner won’t be involved what’s the impact on customers? Was the owner a primary revenue generator or critical in those relationships?

If you’re a strategic buyer, you might not be interested in leaving management in place so it’s good to know again the seller motivations. They may have an interest in that, protecting their employees and key managers, so they may prefer to sell to private equity investors that may have that strategy in mind. So again, understanding that is important upfront. Also note on strategic buyers, they’re generally hoping to increase their margins in operating profit once they combine so that often creates a higher multiple than a financial investor may otherwise pay because you’re expecting those synergies, increased efficiencies eliminating those redundancies.

You don’t want to pay a higher multiple if you don’t think the acquisition will create enough due to sales, whatever it is, new sales, cost savings, increased profitability as a combined company post-merge. Also, good to note if the target’s a competitor, as mentioned, you can expect confidentiality to be a major concern even with the signed NDA in place. They want to protect those trade secrets and customer info so there can also be a concern that word leaks out about a potential sale that could impact customer relationships.

It’s good to discuss this upfront, again, that will prevent delays in getting the data. Also with respect to customers, the main thing is here, we want them to know how likely they are to continue doing business with the target after the transaction. So, we look at concentrations that can create a lot of risk. We see in situations where you have, after the acquisition, a significant large customer has a change in management or ownership and they decide to use another supplier. So those things are good to know, it creates a lot of risk if there’s heavy concentration.

Also, large one-time sales could be buried in the numbers, so we look for that. It’s good to understand attrition with the customers, have they determined what defines that? Have they tracked the rate? Do they understand what caused customer turnover? So again, it’s important to understand that, deep diving the customers, also understanding the pricing models, pricing trends and how likely you can increase prices going forward.

Final note here, as a buyer really, you’re looking for stability, consistency of earnings, so on the flip side of that those types of businesses will typically have… Or businesses without high likelihood of sustainable future earnings created a higher multiple like real estate as an example. There’s a significant hard, tangible asset there but businesses with more uncertainty probably trade at a lower multiple. So as a buyer you’re going to look for something with a lower multiple that you think have potential to generate earnings going forward.

Christy Woods:

Jump in here, their numbers really do tell a story and you digging into them through the financial due diligence process I think really creates an opportunity for the buyer to realize what’s in front of them and to pay attention to those numbers.

We represented a buyer a few years ago and he was just really emotional about the decision to purchase a target and even though we were putting numbers in front of him that didn’t make sense from a business perspective he still wanted to go through with the sale and it ended up being a bad deal.

Jeff Parsell:

That’s a really good point Christy, paying attention to the emotions of a deal and making sure they’re really taking an objective look at the numbers. Thanks for that.

Let’s move on to the next slide here. We’ll start to get into the little bit of the details of the QV before I pass it on. Really we’re going to be looking heavily at the quality of the accounting, quality of the accounting team. Were there a lot of adjustments that needed to be made? Did they have a lot of audit adjustments, if they were audited? Also we’re going to look for biases and aggressive accounting policies that present the financials more favorably that boosts sales or other metrics.

Jim Cordova:

Yeah Jeff, I could. Here’s an area, and I would just add that this could require an alternative working capital calc, especially if you have an unsophisticated target. And I would just add that the key is to make sure that whatever your target working capital is and how it’s computed, make sure it’s computed the same way as the closing and we usually again, suggest adding an exhibit to eliminate any doubt.

Jeff Parsell:

Oh, that’s important Jim, thanks for pointing that out. So cash flow, also yes extremely important, part of that we look at sources of cash, make sure we know if there any restrictions on cash, we look at net income versus operating cash flow in considering risk. So if they have high net income, negative operating cash flows, profits are likely coming from somewhere other than sales. And understanding the target’s working capital needs and trends, so that once the businesses combine post-close you know that there’ll be sufficient working capital to support the transition.

As Jim mentioned, there’s that target, working capital target itself negotiated after close so as a buyer you have the disadvantage of having the details that could hinder that. So that’s something to pay close attention to as a buyer near the close. And then also EBITDA, we want to make sure EBITDA adjustments are non-recurring. They include non-recurring revenue and expenses so generally there more than initially to be expected or identified.

One example we came across the seller used consultants, non-employees, sales commission people, they put that in non-recurring but really a deeper look, those people were necessary for the ongoing business. So, you want to know all the expenses necessary for the ongoing business and only those are included in operations, not in non-recurring expenses.

Jim Cordova:

One thing that we’re seeing just a ton is really the impact of the pandemic. We’re seeing a lot of EBITDA COVID calculations, this may impact the traditional EBITDA calcs and may require forecast based on either a post-pandemic or some blend of that. We’re also seeing working capital is being affected by COVID. Your traditional trending 12 or your seasonal adjusted working capital might be revised to back out 2020 Q2 or even some other pandemic related periods.

Trent Bryson:

Yeah and on top of that, one of the EBITDA items we recently saw was a role up strategy of an ophthalmology group and they had a very rich retirement plan and all these different ophthalmologists had these safe cash balance plans where they were getting $200, $300,000 contributions into their plan. They put them in as the addback and then the next year the seller had expected them to continue to make those contributions which obviously they had taken a multiple on that.

So it becomes really important to understand what the addbacks are to create a nice line item forum and then to also have a conversation specifically with an unsophisticated buyer that, “Hey listen, that’s the whole point of an addback is this created a multiple and therefore you won’t be receiving these on a going forward basis.”

So a lot of times we don’t look at things like pension and benefits and that sort of thing that’s in there, so it becomes important to look at those as you’re going through this as well and just creating a good sense of understanding between both the buyer and the seller.

Jeff Parsell:

Great points, thank you guys. And that just kind of highlights the importance of a collaboration with the other people in the advisor team. And there also may be different models used either than EBITDA and EBIDAC and other things where maybe a free cash flow model. So having that flexibility but really understanding and working with all the advisors and taking a deep look is really important there.

A few more things, kind of, in the details of the QV that we look at. Obviously we look for earnings manipulation, could be through AR, through recent large increase in credit, sales or AR have the east credit terms coming up anticipating a sale, anything that could boost sales in AR where there may be collection issues.

If you’re a manufacturer, cost accounting is extremely important. Obviously you’re going to be looking for good margins as a buyer but if the seller’s not including all expenses in there, it’s simmered down and SG&A such as overhead. Do you really have a clear picture on what those margins are?

CAPEX is another need, what are the needs of the target as far as capital expenditure which it’s operating? So we want to know what those needs are taking a look at fixed asset needs and replacement needs. Often times we find that there’s some hidden value there when you’re comparing fair value to book. We look for unrecorded things, unrecorded liabilities similar to how we would in an audit, cut off issues. Also, we have projections, those are the typically optimistic as we all know. So if the seller says they’ve been doing forecasts for year, you want to look at the older forecasts and compare them to actuals to see what their biases may be and give you some indication on the current forecast.

Just a couple final notes on overall as far as the risk of the deal and the data. A lot of deals fail during buy-side due diligence because they’re not prepared and new things are discovered and then there also external risks, market risks, Fed announcements, unemployment numbers or whatever that could be unexpected timing wise and drive markets. But, the last thing you want is a deal failure or after the close by overpaying, overestimating synergies, you don’t have that strategic plan and most importantly not performing enough due diligence.

So again, QV is really important part of financial due diligence and finally the quality of the data is really critical, timing and quality. If it’s incomplete, inconsistent, creates a lot of risks, creates questions, if it takes too long to obtain it. So that’s something we look for you don’t want the deal to close so again, knowing that the seller is prepared is really important.

Trent Bryson:

As we get into the due diligence side, we’re looking at things on the insurance like benefits integration. All too often we have a company that is buying another company that has maybe richer benefits or worse benefits and so it becomes important to understand how this integration is going to look, what your forecasted costs are going to be. If you went from having an integration that was the company you are buying has worse benefits, it’s going to be important to understand what the cost of those benefits are as well so that when you go into this, you’re forecasting that and then you’re communicating with the buyer firm.

Little things like timely 5500 filings, making sure there’s no waging hour type things that could pop up or workers’ comp issues that Brett will get into in a minute. Understanding any existing key man buy-sell policies that you’ll have to accrue for and then benchmarking, really understanding what this communication is going to look like. If they’re getting any enhancement in benefits or they’re going down in benefits, what that ultimately looks like and why.

And then as we get into kind of the workers’ comp and some of the property casualty stuff, I’ll turn over to Brett to comment a little bit on that.

Brett Hlista:

Sure, thanks Trent. When buyers come to us looking at insurance information basically, they want to see, “Hey what does the seller have in place now? What might be potentially missing? Is there any hidden liabilities and what’s the new cost going to be once we take over this business?”

More often than not, we’re getting pretty basic information upfront, we’re usually kind of last in line of the due diligence process and people are excited and trying to get the deal closed and we’re brought in kind of towards the end. So we’re given a lot of basic information, policy docs, certificates of insurance which are great in determining that a company has insurance in place but doesn’t really give a lot of the fine details.

So the key point here is understanding that when there is change in control, policies need to be re-written and when a policy needs to be rewritten that means that it gives underwriting, it gives carriers the opportunity to re-underwrite the policies. Maybe their appetite has changed, maybe the rates have changed since they’ve written it before. There’s always that liability of, “Hey these premiums could go up quite a bit.” Collecting as much information for us is key.

One of the areas that Trent mentioned is workers’ comp portion of it, most of the time workers’ comp tends to be the highest premium in your program so it’s one of the ones that stands out. One of the largest factors of a work comp policy and determining premium is the experience mod rate. This rate is based on three years of policy losses and payrolls and when you first look into this you see that the insurer has a good loss issue. Maybe they have a credit on a policy, a .80 or higher but when you’re looking into the fine details a lot of the times you don’t see that there’s claims happening in the current year which aren’t picked up on the experience ongoing forward.

Again, it’s just collecting as much information on losses up-to-date losses, making sure what we have to assess the deal properly. The last note is on reps and warranties, we’re starting to see we have been over the last few years reps and warranties policies becoming part of the M&A transaction and more and more deals. It’s basically a breaching contract policy protecting the buyer from breaches of certain reps and warranties in the purchase agreement, limits in policy are 10% to 30% of the deal size and may replace an escrow account set aside for the deal. It’s a complex policy, it’s important that we recommend having someone that has a lot of experience in these deals to look after this for you but it’s a great option for all M&A transactions.

Christy Woods:

And Brett, I think that’s the perfect transition into the tax due diligence. So, similar to what Jeff spoke to on the financial due diligence side, really on the tax side we’re looking into the quality and accuracy of the tax returns that were filed by the target as well as any tax positions that they’ve taken. And to Brett’s point, we work really closely with their attorneys to make sure that those are all well documented in the sale purchase agreement and the reps and warranty section.

With respect to our involvement in the timing of the deal, we feel that we’re able to add more value early on. A lot of the times we’re brought into deals late. As Trent mentioned before, the current CPA doesn’t always have the bandwidth to deal with the transaction so again, the earlier, the better.

Jim Cordova:

Yeah, I totally agree. For us the earlier, the better because we’re much more effective at addressing tax issues if we know about them early on. It is really difficult to unwind the structure of a target when we find out about issues after the fact and you always want to contemplate a tax efficient structure early. It eliminates problems later and it really helps avoid IRS and FTB scrutiny post-close.

Christy Woods:

And one area that we really dig into in the tax due diligence is looking at the tax returns that were filed by the target and that’s not necessarily just looking at the federal and state income tax returns.

Jim Cordova:

No, I’d have to say that the areas of exposure that we see most frequently are state and local tax issues, amnesty filings where the target failed to file out of states, open statute issues and issues involving foreign subs that can extend the statute indefinitely.

Christy Woods:

Those are all good points. Another area that we touch on in the tax due diligence process or tax positions that the target may have taken and I think it’s important to know our day jobs as CPA’s is to work with our client’s to minimize the taxes that they pay and sometimes that results in aggressive tax positions that were taken on their tax returns. So on the tax due diligence side, we’re really looking to identify what those positions are as well as look into any notices that the target may have received and any audits that are underway so that again, we can work with the attorneys and make sure that that’s all well documented in the sale purchase agreement.

Jim Cordova:

Well and here again, there can be issues with foreign subs, sometimes culturally different in business practices create conflicts and these might require either an escrow holdback or additional indemnities.

Christy Woods:

All good points. And then lastly we sometimes have the opportunity to create additional planning opportunities through due diligence, we had one transaction that we were able to identify the seller hadn’t taken advantage of research and development credit so we even worked with the seller post-close so that the shareholders could file amended returns and claim additional credits.

Jim Cordova:

Yeah and I’d say that, obviously the most common are worker classification issues, AB5 a new Californian law has created an increased concern over penalties in this area. A prime example is we have a client in LA, they paid an independent contractor $25,000 and the penalties for misclassification were $475,000 dollars and unfortunately these penalties are not eligible for bankruptcy all can personally be liable under the trust fund recurring roles.

Christy Woods:

Which Jim, I just feel like that’s crazy.

Jim Cordova:

Yeah, it’s the way the law is written. You are penalized for every payment made that was misclassified, so in this case it wasn’t just the 25,000, they paid that individual monthly so there was a penalty at every check they wrote to that individual.

Christy Woods:

Got it.

Jim Cordova:

Other common issues we see include human resource issues especially in this pandemic environment. Pending lawsuits, pension plan with investors or change of control and that’s just to name a few.

Trent Bryson:

Yeah, we had a client recently that had a layoff, they were in the event business and an attorney went and rounded up a bunch of former employees and they had 38 coast termination claims pending which is just obviously brutal and not in terms of the client. But that’s something that would have to be figured out through a pretty thorough due diligence process.

Jim Cordova:

Yeah, great point. All right, now let’s move on to tax structure. Okay, so when we’re talking about tax structure we’re referring to either a stock sale or an asset sale. So let’s discuss that in more detail. The entity structure of the target will dictate whether it’s eligible for stock or asset sale treatment so either of these might require a re-work prior to close if the target is not able to see it’s really important to make sure it’s a partnership for tax purposes, to make sure the buyer gets a step-up in basis.

Jim Cordova:

Valid escrow structure another concern for the buyer and where there’s shareholder debt it can create valid shareholder issues because S Corps can only have one classification of stocks so that’s another pitfall for S Corp acquisitions.

Christy Woods:

And we’ve actually seen a lot of deals recently where the S selection can’t be produced by the target or it was invalid, so we work closely with the legal team and the target in the event that we need to work on some pre-close re-org.

Jim Cordova:

Great point. The sale purchase agreement is the most critical document, you need a strong team that can walk through each turn of the doc to spot any issues. We see a lot of attorneys make drafting changes on the turn that create tax inefficiency so you need to make sure tax issues are considered any time there’s a change made.

Other’s we focus on are burnout issues, purchase price allocation issues, working capital, equity roller of the seller. Christy, any other thing I missed?

Christy Woods:

No, I think it’s just really important in working through the sale purchase agreement that we make sure there are number things that are really well documented. We just had a deal that closed over the weekend that had a very robust earnout in place and we worked very closely with the seller’s legal team to make sure that there was the legal structure documented in the sale purchase agreement both pre-close and post-close.

Another area that we really tend to focus on are the exhibits and we like to make sure that everything is well-documented in those exhibits. That includes the purchase price allocation in addition to any target working capital.

Jim Cordova:

Yeah and I would just add, for a promotional point we like to air on the side of caution, and we use more exhibits to reduce conflicts post-close. Jeff do you have anything to add to that from your stand point?

Jeff Parsell:

Thanks, yeah jumping in just on that from a financial reporting perspective here regarding the purchase price allocation. Often under GAAP, General Accepted Accounting Principles, compared to tax, you have differences in how that’s treated so specifically respect to goodwill, intangible assets, how they’re recorded, how they’re amortized on the books of the buyer post-close.

The second point there is asset purchases can often be considered business combinations no doubt, so in which case they’re accounted for the same way as a stock purchase. All the assets and liability are recorded at fair value as an acquisition of a, quote on quote, business so the PPA under GAAP could look the same whether it’s an asset or stock purchase. So if you present GAAP financials to outside parties it’s good to know pre-merger or acquisition that you don’t have a surprise when you go to prepare the consolidated financials post-transaction.

Jim Cordova:

Great add Jeff, thank you. So post-close we stay well involved assisting with working capital true-ups, purchase price allocation statements, valuation of assets, there’s always issues regarding pre-close straddle period and post-close tax return issues, earnout tracking… Christy do you have any additional comments to add to that?

Christy Woods:

Yeah I think just from a representing the buyer from a compliant standpoint we always like to make sure that there is a section in the sale purchase agreement that allows for the buyer to review the tax returns that are going to be filed by the seller prior to their filing deadline.

Jim Cordova:

Thank you.

Christy Woods:

Like Jim mentioned we’re talking about a stock sale or asset sale, so we’ll dig into a stock sale first. A stock sale is the purchase of all the assets and the liabilities of the target company. Eligible entities for a stock sale really were thinking about a change of ownership so that means a target with a C Corp or S Corp stock.

Jim Cordova:

And Christy I just want to add to that, the buyer really needs to watch for foreign issues if the target is formed in other jurisdictions. You could have a corporation under the foreign law but that entity may be disregarded under US law and we see that a lot.

Christy Woods:

Yeah, we have seen that a lot. One of the pros of a stock sale is that all of the contracts of the customers stay intact so, like Brett mentioned, there’s no change in control and that’s something that’s a benefit to the buyer.

Jim Cordova:

Yeah and I would just add to that, this eliminates assignments and approvals which many times hang up a deal.

Christy Woods:

Good point. And one of the cons is the buyer’s actually assuming all of the liabilities of the seller and we hope to uncover a lot of those through the due diligence process but that can also include any contingent liabilities or unknown liabilities.

Another con is that the fair market value of the purchase price is trapped in the stock basis values, there really hasn’t been a event that’s taken place for the sale to require a step-up in basis, the buyer steps into the shoes of the seller and therefore their purchase price is locked in the stock.

Jim Cordova:

Yeah, I would just add to that, that when you do a stock purchase because the purchase price is tied up in the stock basis, as Christy mentioned, the buyer can’t really monetize that until they have a future liquidity event.

Christy Woods:

And I think it’s important to think from a seller’s perspective, this is really the most attractive way to sell their company. They’re going to get preferential treatment on the sale of their stock so that results in capital gains taxes which are lower than ordinary rates.

Jim Cordova:

And I also say that there’s one other consideration that might drive a stock sale and that is the small business stock exemption. We see a lot of that with middle market companies. All right, now we’ve discussed stock sale issues let’s talk about asset sale.

In an asset sale we identify a specific asset of the target to be purchased, however if the target is a partnership, because of the mechanics of the entity and the basis adjustment issues, buyers are always treated as having purchased the underlying assets. For S Corporations a little different, we can do a deed asset sale which is when the stock purchase is treated as an asset purchase for tax purposes only. This gives the buyer/seller the best of both worlds and because of that the buyer’s generally willing to pay more.

An asset sale minimizes the liability to the buyer because they don’t inherit pre-acquisition liabilities, so they basically get a clean slate.

Christy Woods:

I think this is a really important point to drive home when we talk about the stock sale we really understand that all of the assets and liabilities are assumed and that’s a greater risk to the buyer, whereas here the buyer’s really only taking on any liabilities that are part of working capital.

Jim Cordova:

Great points. The step-up in assets creates a tax shelter on future taxable income so this effectively allows for the buyer to amortize the entire purchase price of the deal.

Christy Woods:

And Jim, I think we’ve seen this so much recently that the buyer is willing to pay a huge premium over the valuation just because this is a huge added benefit.

Jim Cordova:

Yeah and it’s easy to calculate it and prove the benefit. Lastly, an asset sale can potentially be less attractive to the seller because of all the income tax implications and typically when we have those problems we see a provision providing for tax gross up to make the sale a whole and the gross up is just treated as additional sales proceeds.

Christy Woods:

And I would just like to drive home again, the earlier that we can all be involved in the transaction, whether it’s the insurance team, the CPAs, the attorneys, we can really add more value and help you as a buyer with your transaction. We’ve had deals that we’ve been involved in pre-LOI and we’ve been able to put a cap in the LOI so that the buyer’s purchase price is limited with a reimbursement to the seller.

Trent Bryson:

As we move on to the next slide, I think that something’s really important in all of this is a lot of times we find buyers say, “Hey we want to not involve the professionals until the very last minute because they’re thinking about their own fees.” But I think what you see is that it ends up being the other way around, the sooner you involve your partners in the deal, as Christy talked about, the better off it is for everybody. It just becomes so much more critical to everybody be on the same page.

If there’s any questions on anything that we’ve discussed today, don’t hesitate to reach out. We’re also sending out this entire presentation so that you can use it as a bit of a checklist to kind of go through and prepare your team but like I said, if it’s a question for myself, Brett, Jim, Jeff or Christy, don’t hesitate to reach out, we’re here to help.

Thanks for your time today, I appreciate you listening in and hope to see you soon.


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